COVID-19 has turned the world upside down and with it many investment principles. Ashley Kopczynski, Associate Portfolio Manager – Credit & ESG, from the Janus Henderson Australian Fixed Interest Team discusses whether infrastructure is still a valid defensive investment.

  Key Takeaways

• Negative oil prices, empty airports, deserted toll roads and collapsed airlines – all scenes unthinkable just three months ago.
• Many infrastructure companies operate with relatively high leverage because of their strong market position leaving them potentially exposed.
• There are many levers that can be pulled to ensure they survive and re-emerge as essential components for the economy to function.

What attracts investors to infrastructure debt?

Airports, toll roads and container ports are crucial for the Australian economy. They often operate as monopolies in their particular regions and can offer stable and predictable cash flows, with growth often tied to population and GDP growth.

They have been great credit investments because of this predictability of cash flows and by in large have met our quality before price approach. In addition, infrastructure debt has given our investors access to companies that they cannot typically get in the equity market because most are owned by long-term infrastructure owners, such as domestic and overseas super funds.

Because of their strong market position, they can operate with higher leverage, namely higher gearing than pure corporates, along with lower interest coverage. Think of it as a weaker financial position being offset by a stronger business position.

Infrastructure companies hurt by shutdown

But the COVID-19 shutdown in activity has impacted these companies meaningfully. Planes have been grounded, toll road revenue is down as millions work from home and no longer commute and disrupted supply chains have hit the volume of goods being imported and exported. Companies with stable revenue only a few months ago have seen demand for their services plummet.

What now? Do these companies maintain a reason to exist? Are they likely to default given their main strength – their dominant market position – has disappeared? Or will they survive to see the other side of this?

For pure infrastructure companies, we believe they will survive.

Many levers to pull

We have had contact with the airport management teams, as well as the credit rating agencies in recent weeks and for pure infrastructure companies, particularly airports, the months ahead won’t be easy. A range of issues were discussed, such as liquidity, scenario and stress testing, as well as opportunities for additional funding. We believe they will survive and management actions to-date have been encouraging.

Sydney Airport and others have suspended dividends as a way to preserve cash. They, along with companies like Transurban, have either extended bank lines or issued bonds to address any immediate refinancing risks. Operationally, costs can and are being reduced.

And, of course, balance sheets can be strengthened by raising equity. These equity owners are long-term investors that will fight tooth and nail to retain exposure to these assets that they fought hard to acquire. In the worst case, we suspect there are plenty of other prospective equity investors willing to acquire positions in these essential firms should an opportunity arise.

While we expect credit rating agencies to be patient, we are not ruling out negative rating changes. However, we also expect common sense to prevail if these companies are at risk of breaching debt covenants and expect lenders will be willing to waive covenant breaches (should they occur). Generally, these breaches will not be due to aggressive management teams driving up leverage, but rather a result of government-imposed distancing measures impacting revenues.

In summary, there are plenty of levers that can be pulled to ensure the long-term viability of these companies.

Infrastructure remains essential

While many things will be fundamentally different in a post-COVID world, we still see these sectors as being essential, even if a return to pre-COVID revenues takes a number of years. Moving goods and people in and out of the country and helping people get to and from their daily tasks are essential to our economy functioning.

Purchasing the bonds of high quality firms in their darkest hour has historically been fruitful for patient investors. Being a senior bond holder in these companies is a way to earn consistent income and we are attracted to this. In addition, we see the prospect of capital gains from ordinarily defensive companies as attractive for our portfolios.